up and down, up and down, repeat

the reform in retirement accounts that’s not coming

If you want me to get started on a rant about personal finance, ask me about retirement accounts. From the “no-taxation” benefit of Roth accounts (yeah, the government will never touch those) to the “benefit” of 401(k)s (no better benefit than having your retirement savings steered into a narrow set of corporate-defined funds), retirement “savings” are a bum rush.

If you look at the tax-advantaged system in the US, it favors publicly-traded corporate equities – and the mutual fund giants who trade them – to an overwhelming degree. 401(k)s, IRAs, CDs, etc. – all favor the large financial institutions favored by the government. Want to put some money into a tax-free IRA? Better be ready to put it into the stock market. If you want to invest it in the real estate market – an individual property, not a REIT – or a non-public business (investing $10K in a neighbor’s company), forget about it. The government wants you in the market.

I’ve thought that one of the most exciting reforms that could come in personal finance would be a real reform in retirement savings. Tell people that there is one choice – a retirement account, tax-free up to a set limit per year, that you could invest in anything. Anything. Want to invest in your neighbor’s eBay business? Your own dog-walking business? Anything would be allowable as long as the principal remained in the account.

The problem with such an account is obvious – keeping track of the investments and verifying that they are really investments would be difficult. If I claimed a TV as an “investment” in my retirement account it would circumvent the idea of such an account. But why should the only government-sanctioned way to save money in a tax-free account be to invest it in the stock market? Wouldn’t tax-free investments in other activities help the economy even more than buying corporate equities?

The easiest way to implement such a system would simply be for the IRS to allow you to deduct a certain amount of income from your gross income as long as it was spent on certain activities. If I spent up to $6000 on building a small business, for example, I could simply deduct that from my taxes. If I spent $6000 on a trip to Vegas, it wouldn’t be deductible. To me, it’s a simple idea and far more fair than forcing investment in the market; but then again, that’s why it won’t ever happen.

11 comments

Ah, oops, good point, Jeremy and Brandon. I think the Self-Directed IRAs are not very common – a quick search didn't show up any of the major retirement account providers offering them. I'd think most people – myself obviously included – might not be aware that's an option or have the wherewithal to set one up.

Yet they are out there, so I guess my rant's largely pointless (although it still applies to 401(k)s, which are a major focus for a lot of employees' retirement plans). In my defense, I'm still not sure why we can't have a unified system for retirement plans, though.

I agree. I don't see why the government couldn't come up with a default, yet voluntary retirement account. Then, make it so that every employer has to offer it and if the employee wants to take part it just comes out of payroll just like their taxes or other 401k. Then make the investment choices very simple and relatively safe. This would at least provide EVERYONE the opportunity to save something easily under one standard plan. Think of something like the military TSP but for everyone.

At the same time, leave the options open for additional retirement savings via IRAs and the like for people who actually want more control, options, and to save even more. Some people know what they are doing and can really benefit from additional savings so they should have that option. But at the very least there should be a basic retirement savings plan that everyone has the option to enroll in and have it all managed the same. If people want to go above and beyond that, then then let them decide where to invest that money.

We just have to level the playing field. With things like 401(k)s where only some employers even offer it, and the ones who do having hundreds of plan sponsors to choose from it's almost a crap shoot for the average person. Are they going to have a job where they even have a 401k? If so, are they going to get raped with fees or be one of the lucky ones who actually get a low-cost plan with decent investment options?

IMO it isn't far to basically tell people they are on their own when it comes to saving for retirement while not even providing a basic and standard option that's available to everyone equally.

@Patrick – my feeling is that it works this way: how does the $10K that I invest in Fidelity's Megacorp Mutual Fund “stay” in the account? It's out there and “spent” to buy the shares. It's all in the accounting. It could be handled like a trust. You send the money to a “super-retirement” administrator and they dole it out to whatever you choose – and they don't return it until you cash out on retirement.

Or, the simpler way would simply be to give everyone X amount tax-free every year, as long as it was invested in certain ways. If you chose to invest it and then pull it back out, fine, but then you'd lose any tax-free growth benefits and you'd have to “re-declare it” as income.

I'm sure there are ways. Investing in Citigroup is no different than investing in your neighbor's CPA practice except that the former is (theoretically) a little bit more structured.

What you're suggesting is kind of like a corporation. The money to buy equipment, supplies, and investments doesn't “stay” in a corporation; but all the accounting for it does.

Right now an S corporation comes pretty close to allowing you to have a business and treat its revenues like deferred savings. An S-corp is a pass-through entity. It doesn't pay taxes.

You as the owner (director) have to pay yourself a “reasonable salary.” What's reasonable is decided by you, though the IRS can have something to say about it — better not, for example, pay yourself less than minimum wage. But you don't have to pay yourself what your time would earn on the open market…and certainly not what it earns for the business.

Since the corporation is paying you a salary, you pay your share of FICA and the corporation pays the employer's share. As for the money that remains in the corporation after your salary & FICA are paid: it can sit there until the cows come home and the corporation pays no taxes on it.

You withdraw the money that's not salary by having the corporation distribute it to you as dividends. You then pay your regular income tax on dividends…but because it's not a salary, you don't pay FICA on it, a significant advantage. And obviously, if you have a day job, you can let the dividends accrue until you retire, when your income taxes presumably would drop somewhat. No law says the funds have to sit in a savings account; you could invest them in any number of instruments.

You probably couldn't use an S-corp to invest in your cousin's McDonald's franchise. But you sure can incorporate your own moonlighting business, allowing a significant portion of the proceeds to accrue tax-free.

Two other advantages to an S-corp are 1) because the dividends aren't taxed for FICA — they're dividends, not salary income — you can withdraw them and it doesn't count against you if you take early Social Security; and b) if the corporation needs to purchase capital equipment (say it needs a computer or a printer) or anything else (office supplies, for example), because it doesn't pay taxes, it effectively purchases them with pretax dollars.

If you want to think of it as a way to defer compensation, its advantage is the ability to leave revenue sitting there until you choose to withdraw it in the form of dividends.

As with any corporation, you need to respect the corporate veil. It can't invest in its owner's home entertainment center, and unless you have a good, provable business reason to travel to Vegas, trying to make the corporation pay for the trip would be exceptionally unwise. Common sense, a whisper of integrity, and up-to-date bookkeeping will protect a person in that department.

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